A living trust is the ideal estate planning tool for a wide range of different people. We are going to look at the tax implications in this post, but before we get there, we will explain some of the benefits that living trusts provide.
Simplified Estate Administration
Many people think that the estate administration process is very simple when you use a will. They assume that by comparison, trusts are extremely complicated. In reality, nothing could be further from the truth.
If you use a will as an asset transfer vehicle, you name an executor in the document to serve as the administrator. This individual will not be able to act independently without supervision.
The will would be admitted to probate, and the court would preside over the proceeding. There is a proving of the will, which is an examination of the document to determine its validity. Final debts must be paid, so creditors must be notified, and they are given time to come forward.
During this process, the executor will identify and inventory the assets and prepare them for distribution to the heirs. This can involve appraisals and liquidation of property, and this can sometimes be a lengthy process.
All things considered, it will usually take between eight and 18 months for probate to run its course. No inheritances are distributed while the estate is being probated, and the expenses are accumulating while the clock is running.
The dynamic is entirely different when a living trust is utilized. When a living trust is being administered, the trustee can distribute assets outside of probate. As a result, all of these negatives never enter the picture.
Ongoing Control and Flexibility
You would act as the trustee while you are alive if you establish a living trust, so you would have ongoing control of the assets. If you want to change the terms, you can do so at any time, and the trust would be revocable while you are living.
Asset Protection for the Beneficiaries
You can include a spendthrift provision when you establish a revocable living trust. After your passing, the trustee that you name to succeed you would step into the role, and the trust would become irrevocable.
The trustee would control the purse strings in accordance with your wishes. The beneficiary would not have direct access to the assets. Because they would be out of the reach of the beneficiary, the same dynamic would apply to the beneficiary’s creditors.
Creditors would be able to reach assets once they have been distributed to the beneficiary. To account for this, you can instruct the trustee to provide limited distributions on an ongoing basis.
Taxes on Distributions
Now that we have provided a general overview, we can get to the specific point of this post. The principal that is in the trust at the time of your passing was left over after you paid taxes throughout your life. If distributions of the principal were taxed, it would be double taxation.
As a result, a beneficiary would not have to report distributions of the principal as income on their tax returns. However, distributed interest earnings would be taxable to the beneficiary. Moreover, the trust would be required to pay taxes on undistributed appreciation.
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